Taxpayer nightmares on bail out street

State bail outs are usually bad news.

They are clearly bad news for taxpayers. We get lumbered with having to pay for businesses which have lost money and become too expensive for their shareholders and bankers to keep going.

The British experience demonstrates that they are often bad news for the very people a bail out is designed to help. In the 1970s UK government put huge sums into leading industries, only to make them some of the worst employers, endlessly sacking staff despite the hand outs. The nationalised coal, steel, and rail industries fired large numbers of people, whoever was in government and however much taxpayers money was tipped in.

The bailed out industries were not good news for their customers either. Far from enjoying cheap subsidised prices, they often faced big real increases in prices. Where bail out was allied to monopoly customers were clobbered.

In “Going for broke” I made the case against state subsidy of industry in the early 1980s, based on UK experiences in the 1970s. We won those arguments. A new generation of politicians, Labour as well as Conservative, started to repeat the new mantras – “Government is no good at backing winners” and “ Subsidy just delays sorting the bad business out, it doesn’t save the jobs”.

It is worrying that these crucial lessons seem to have been lost on both sides of the Atlantic. The US and the UK authorities seem to think these rules do not apply to banks, for some unspecified reason. Now the US is considering a second bail out of GM and Chrysler, just a few weeks after the first bail out. When will they learn?

It is not difficult to see why bails out rarely work. If senior management think cash comes from taxpayers, they devote their energy and time to wooing the state instead of wooing their customers and sorting out their businesses. If employees think the state will rescue their job it takes some of the pressure off to help the company find the new customers it needs to pay the wages. Above all it stops the energy and thought of how to change the business to make it successful.

What would happen, some ask, if the state does not step in and buy shares in banks and car companies? The answer is the radical restructuring needed takes place more quickly, perhaps reducing the total loss and pain brought on by subsidised delays to the process. Of course no main bank should be allowed to go under, as the Central bank is their lender of last resort. If they need last resort lending, it should be made available on promise of radical restructuring and slimming down, to get the bank back into commercial shape. If a car company needs money it can get it from its own bankers. If they are not obliging, then it needs to sell assets and find new equity backers. They will be there, even in these conditions, for a business plan which makes sense. Only the state finances dud business plans as a matter of course.

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16 Comments

  1. Posted February 18, 2009 at 7:55 am | Permalink

    Of course no main bank should be allowed to go under

    I realise, John, that there might be limits to what you can say on your blog, but I have to ask: what is so special about banks that they can’t go under? If deposits are guaranteed by the government, then a few banks going under would have certainly prevented a re-run of this in the future. As it stands now, banks have been told that they are entitled to have as much moral hazard as they want!

    • Posted February 18, 2009 at 6:54 pm | Permalink

      Just to change the subject for a minute – with prior permission from Mein Host! – it’s been a good day for People Power with news of:

      A. The small shareholder who is to make a claim on RBS in the small business court for his losses incurred from misrepresentation of the bank’s financial position prior to, we think the news said, the rights issue last year.

      B. The U-turn by the Parliamentary Ombudsman who is now to investigate the Home Secretary’s housing arrangements and claim…all because her neighbours made a complaint in the public interest. Mumbling by MPs and the media didn’t do the trick but ordinary voters’ voices did!

      In response to John’s blog this week, and without getting too carried away, is this further encouragement to us all that we CAN have our say and make a difference?

      • Posted February 19, 2009 at 8:15 am | Permalink

        With regard to RBS rights issue claim of misrepresentation of accounts you highlight.

        I understand that Shell were taken to Court in a class action last year in th US about understating their Oil reseves to shareholders.
        I belive that Compensation of hundreds of millions looks like it is being, or is going to be awarded to Shareholders.

        If this case is successful or not it may not be the last action, as RBS shareholders are Worldwide, and the US is keen on litigation.

  2. Posted February 18, 2009 at 8:06 am | Permalink

    When the bail out of the Auto Industry in the States went ahead back in January the likes of Ron Paul, Peter Schiff and Jim Rogers warned loudly and clearly that the burn rate of the companies concerned was so high that they would be back for more money in 2 or 3 months. They were ignored. Much kant was spouted at the time about how rigorous the conditions were that were being attached to the bailout.

    Well on the news this morning it transpires GM at least is back for another handout warning that if it does get it the firm will go into meltdown and that in the long term the govt will eventually have to bailout it out but at a much higher cost than the amount they need now. In my view this suggests that Schiff et al were right in their analysis back in January – contra Bush and Obama.

    I appreciate people are desperate to find a structured, planned way out of this crisis but I really don’t accept that a govt bailout will enforce the type of structural change that these companies need. Its not a question of being heartless or uncaring. Rather its a case of facing up to economic reality. Each bailout is a lifejacket with a hole in it that helps the recipient to keep their head above water for a short time. Political incentives are such that once the bailout is granted then the recipient is engouraged to go back for more and the donor (i.e., Central/Federal Govt) is encouraged to say yes so as to save face and cling onto to power. I accept the latter is in good faith – in the British context whatever Brown is I don’t believe he is clinging to power for the sake of it but because he thinks he can improve things if he remains in office. I think he is wrong and will make the situation much worse.

    One other thing: Rogers was right about the US Auto bailout. What else is he right about? In particular how accurate is his prediction that the UK is finished and that sterling is in terminal decline? Personally I fear the worst on that front aswell. Why? Because of the alarming move towards Quantitative Easing and the staggeringly high levels of public debt that Brown/Mandy is mounting up. These, combined with their refusal to let the market clearout the malinvestments that have built up over the last ten years, seem destined to lead us that way. Predicatably the BBC have simply dismissed his comments on sterling as those of a machiavellian speculator. Oh for an intelligent public broadcaster that debates real issues on the economy rather than toes the Labour govt’s line all of the time …

  3. Posted February 18, 2009 at 8:34 am | Permalink

    No one ever seems to learn that when a business is in a loss situation it always, but always requires more cash than at first requested.

    When a business needs to be turned around It always, but always, takes longer than first planned.

    Whenever a Company goes bust its losses are always, but always, greater than at first thought.

    Does no one ever learn this very simple lesson of history.

    When ever a Business seeks finance you should always look very deep into the accounts, and then allow a significant contingency sum.

    No surprise that those who have already had a bail out now require more, as the real scale of their finances becomes known.

    The Companies in Competition who were profitable then have to fight against those which have been given a lifeline by the taxpayer.

  4. Posted February 18, 2009 at 9:23 am | Permalink

    We are told nowadays that the banks are too large to fail. We were told before that we needed huge banks (and other companies) so that we could compete on the globalised economy. Well which is it? I think we need to decide, because it is beginning to look to me as though the tail is wagging the dog.

    I think we need to go back to basics and figure out what we mean by a globalised economy, and figure out what the implications of it are. Is such a thing desirable? Do we merely mean a version of free trade? Or do we mean something more? I read about globalisation all the time, but very seldom do I see it defined.

    I am beginning to suspect that a globalised world economy carries the same threats to liberty as the EU — namely that it is not possible without a globalised government. And a globalised government will not be our own government.

    As for the banks, if they are too big to fail, then they are too big. Period.

  5. Posted February 18, 2009 at 9:28 am | Permalink

    The Govt is now deciding who will be the winners and losers in more than just subsidies. It is now obvious the country (world) has lost trillions and now it needs to be decided who will take the losses. If the Govt prints money then the savers take the hit via inflation whilst the debtors are ok. If they dont print money then the debtors take the losses via deflation. Its the same with Govt spending, if it stays high the private sector takes the loss via higher future taxes and higher interest rates due to competition for funds with the public sector. If they cut then the public sector loses.

    I guess they will try to share the pain but ultimately they will be defining which groups lose which amount…. the question is how much has been lost and which groups can take on the losses the best for the economy to recover……

  6. Posted February 18, 2009 at 9:34 am | Permalink

    Irwin Steltzer, senior fellow and director of Hudson Institute’s Center for Economic Policy is a sensible economist who we often see in the British media on programmes such as Newsnight when there’s an economic crisis or policy change to discuss. I share his opinions of how the free market economy is supposed to operate, and how capitalism is the most preferential means to create wealth and lower global poverty, and that regulatory controls must of course be able to protect the system but should not be too stringent so as to stop its ability to work all together. I recall him in an interview late last year with Jeremy Paxman when he sat across the opposite side of the Newsnight debating satellite to Naomi Klein.

    Naomi Klein, author of Shock Doctrine, is a major league critic of the economic system which by its essential need for continual growth seeks continuous enlargement and fails to compliment the essential elements of democratic support. In short, the current economic system is essentially developed by corporations which have no political attachments or issues such as sovereignty or democratic allegiances to consider. There are many examples of this but one recent example is the relocation of Dell to Poland with the loss of 2,000 jobs in return for a fat grant from the Polish government which gave no social considerations for the people of Ireland who were left unemployed and are doubtless wondering what the system did for them.

    Going back to that interview “Does capitalism still work”, I recall Naomi Klein was unable to answer when asked “What would you replace it with”, and felt the interview could have carried on for a lot longer if she’d been given time to answer. In the end, Irwin Stelzer was left shaking his head, but I believe he too can see there are improvements which can and should be made.

    He writes an article in today’s Telegraph on Gordon Brown and Britain’s demise which I found very enlightening, in which he describes the period of Brown’s term in government as Chancellor and as Prime Minister. He makes references to his refusal to admit blame, his continual blaming of economic problems to America, and of his undemocratic denial to hold a refendum on the Lisbon Treaty.

    I think if Naomi Klein and Irwin Stelzer could get together and thrash out a decent plan for our system, that their combined minds would have the balanced system we need, to incorporate free market capitalism, social conscience, a regulatory framework which protected itself and the consumer but didn’t stifle itself or its purpose, and which held majority democratic support. Rather like Dmitry Medvedev and Vladimir Putin have in the Russian Federation, which is working well enough within a global economy but without the globalisation of American capitalism which has skrewed everyone in Britain, Europe and America who are left to face unemployment because a corporation decides to move to somewhere like Poland because they are offered a ‘grant’ of more money. I think the only difference I can see is that in Russia, they’d call it a ‘bribe’.

    “We have to regulate the degree of leverage involved” – Steltzer.
    “The system works but we shouldn’t privatise everything and people need more wages” – Klein.

    I think that’s the basic thing we should understand.

    We should not privatise EVERYTHING, and we need to prevent over leverage.

    For example, I’m aware that an EU commission is “looking at energy prices” with the question “are we paying too much”. They ‘intend’ to take a YEAR to deliberate this and ‘intend’ to reduce prices of energy.

    I’m also aware that our energy costs TWICE as much as the suppliers buy it from Russia. Further, that the UK price is decided by the market rather than by the government as we’re in an energy agreement which in plain simple language amounts to a CARTEL.

    Despite the suppliers are ‘private’, and despite they DOUBLE the price they pay, to sell us our energy ( when they do little more than send it along a pipe ), and the government then places TAX on it and gives the company grants, despite it having made massive immoral profits as a result of causing many millions of people grave hardship and poverty, not to mention the social problems left behind in its wake as a result of over – privatisation which ignores the social consequences.

    For those reasons:

    * A cartel is immoral.
    * Doubling prices to the consumer for an essential life sustaining product such as heat, is immoral.
    * A commission looking at something which is as plain as the nose on my face is to me when I look in a mirror, yet deliberating for a year to discover it really is my nose, is immoral when the delay causes greater poverty.
    * Whilst poor people are placed into poverty for want of heat and light, and when old people die for lack of it and when babies die or contract pneumonia and mothers have their children taken from them for lack of ability to ‘care’ or feed their kids for reason of poverty, it remains immoral.

    Energy should not be privatised, it should not be taxed and the EU should stop its immoral bleeding of taxes which is creating MORE poverty even in our own nations.

    No amount of speeches to end poverty will remove the poverty caused by the EU ( and governments ) which are bleeding people dry and are themselves CAUSING the poverty in the people and massive profits for corporations and the banking industry, neither of which have any social conscience.

  7. Posted February 18, 2009 at 10:54 am | Permalink

    Milton Friedman will be turning in his grave. Ayn Rand likewise. It’s one thing make honest mistakes; it’s quite another to make mistakes based on statist principles that lost all integrity (empirically and philosophically) many decades ago.

    Have we learnt nothing in the last 100 years or so? Ronald Reagan – a man of keen common sense if not academic learning – famously said the following. Read and wonder at the insight contained:
    “The 9 most dangerous words in the English language are ‘We’re from the Government and we’re here to help'”!

  8. Posted February 18, 2009 at 12:33 pm | Permalink

    I’ve been wondering what should happen when a strategic company goes bust. We had it with Railtrack, and now we’ve got it with the banks. These companies are “too big to fail” in that they cannot simply be replaced by their competitors.

    Perhaps we need to extend the bankruptcy code, to deal with this situation. If a strategic company becomes insolvent, the government could be given the right to make directions about the way the bankruptcy proceeds.

    For example, suppose Railtrack had called in administrators. With my scheme, the government would then decide what happened next. If it wanted to set up Network Rail, it could direct that the bankrupt company’s assets be transferred to the government.

    This would not disadvantage shareholders; they have already lost their money, because the company is bankrupt. It would, however, disadvantage creditors, and they would have to be compensated. To begin with, the government could negotiate compensation with the administrators. If they were unable to agree the amount, the matter could be decided by the judge who made the bankruptcy order.

    I used Railtrack as an example because it is simpler than the banks. This system could also be used with a bankrupt bank, though. The government could, for example: direct that the bank wind up its derivatives book; direct that the bank continue making loans to its commercial clients; not pay bonuses; or whatever is felt to be most helpful for the wider financial system.

    Because the bank is bust, the government can choose which creditors it will support. Currently, bust banks owe money to their depositors, their commercial creditors, and they owe money to their traders in the form of contractually agreed bonuses. As a matter of law, the bank must pay all these people while it has the money to do so, even if that money comes from the taxpayer. On the other hand, if the bank is bust, the government could direct that it continue making payments to retail depositors. This would involve the payment of compensation, because other creditors would otherwise be disadvantaged. However, the government need not provide money for contractual bonuses if it didn’t want to. If it chose not to, people entitled to those bonuses would be unsecured creditors, entitled to a share of the money when the administrators eventually sold or refloated the bank.

  9. Posted February 18, 2009 at 1:13 pm | Permalink

    I broadly agree with the purity of your economic analysis of this but at the same time find myself peculiarly sympathetic to the position the Government is trying to deal with (as opposed to thier role in creating it).

    On one hand your assertions are completely correct and yet at the same time I wonder if there is a single Government who would be willing politically to allow thousands of business to go to the wall and millions of voters to lose thier jobs if they thought they could prevent that.

    So I am torn between being mortified at the volume of Government borrowing (deferred taxes) which are now being thrown with increasing regularity by our Government at ‘cases which can’t be allowed to fail’ and wondering what the landscape of our economy would look like today if the Government had allowed Northern Rock, HBOS and possibly a number of other banks to collapse 16 months ago.

    I suspect that the answer to the question lies in the approach being taken. A Government which chose to (as you often suggest) try and tighten it’s spending commitments and eliminate waste, whilst committing support to businesses and individuals in the form of significant (albeit temporary) tax reductions would attack the problem from the other direction – of reducing everyone’s outgoings and freeing up cash which would then find it’s way back into the economy.

    Unfortunately we are where we are, and Brown the Controller wants to have his tax/spend cake untouched, and seems unwilling to trash the complex edifices of his tax credits system with such measures. The state sector continues to grow whilst taxes and Government borrowing increase unabated as the private sector faces the full brunt of a recession and a future of paying for it all.

    Clearly the electorate is displaying very clear intentions of removing Brown and his cohorts from office at the next election. My sympathies go out to whoever will inherit this shocking mess. It’s not a job I would relish solving, and more so because it seems fairly clear to me it will take more than the lifetime of a single Parliament (or even two) to balance the balance sheet that Gordon is going to leave us with.

    • Posted February 18, 2009 at 8:51 pm | Permalink

      Sadly, government intervention always only delays the inevitable at a greater cost – we need to move through this horrible period of destruction, any interference will actually make it worse.

  10. Posted February 18, 2009 at 2:22 pm | Permalink

    John, a bit off topic, but doesn’t this article :-

    http://www.bloomberg.com/apps/news?pid=20601068&sid=a_YrfCU4wkN4&refer=home

    mean that the Bank of England is about to start printing money?

    “Feb. 18 (Bloomberg) — Bank of England policy makers unanimously agreed to ask the government for authority to create money in an effort to kick start the economy, saying further interest rate cuts may hurt the profitability of banks.”

    If so does this really mean we are about to “go Weimar” and end up buying loaves of bread with wheelbarrows of worthless pounds?

    As that rare man who is both a politician and in possession of an economic clue, I would appreciate your thoughts on what appears to be a very serious matter.

    Reply: yes it does, and yes it could become serious if they do too much of it.

    • Posted February 18, 2009 at 4:27 pm | Permalink

      Perhaps its the right time to start up a wheelbarrow Company !!!!!!!

  11. Posted February 18, 2009 at 3:27 pm | Permalink

    I would make one point about this:

    We shouldn’t be suprised that people have forgotten these lessons.

    To para-quote Maggie: “You can never stop winning the argument!”

  12. Posted February 18, 2009 at 10:36 pm | Permalink

    As a further aside could we commend to all your readers the article by Irwin Stelzer, the American economist who invariably speaks sensibly on the British economy , in today’s Telegraph.

    We feel that it’s one of the most fierce and ruthless but measured summaries of a British politician that we’ve ever seen from an overseas commentator. It contains the very sentiments that this blog – and those of other thinking Conservatives – have been expressing for a long long time!

    The summary of the article is as follows…

    Irwin Stelzer: BRITAIN CAN BE FIXED – BUT NOT BY A PM WHO WANTS TO SAVE THE WORLD

    “It is a pity that Gordon Brown has decided to substitute truculence for calm reason when confronted by his critics. For my guess is that when the history of the Brown era is written, he will realise that his defensiveness; his unwillingness to admit a single error; his dishonest effort to paint the Tories as a do-nothing party, despite the fact that some of their ideas were so sound that he filched them, detracted from his real accomplishments.” – Irwin Stelzer writing in the Daily Telegraph

  • About John Redwood


    John Redwood won a free place at Kent College, Canterbury, and graduated from Magdalen College Oxford. He is a Distinguished fellow of All Souls, Oxford. A businessman by background, he has set up an investment management business, was both executive and non executive chairman of a quoted industrial PLC, and chaired a manufacturing company with factories in Birmingham, Chicago, India and China. He is the MP for Wokingham, first elected in 1987.

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